Iea Chapter 10

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MAJOR PROBLEMS FACED BY CHINA’S BANKING SYSTEM
▪ Agency Problems
▪ Capital Inadequacy
▪ High volumes of non-performing loans

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Causes of Agency problems
▪ Before restructuring, bank managers had no stake in the state-owned banks. Hence, they make decisions that will benefit themselves at the expense of banks’ profitability ▪ Loan officers were rewarded based on the volume of loans ▪ China’s strong credit culture, compounded by the weak legal system caused difficulty collecting loans. managers lose incentives to monitor loans as they do notexpect loans to be repaid

CAUSES OF HIGH VOLUMES OF NON-PERFORMING LOANS (NPL)
▪ Agency Problems
▪ Bribery
▪ Government encourage banks to fund state-owned enterprises ▪ Soft budget constraints
▪ Failure of market discipline

1) Agency problems: As above

2) Bribery: Prevalent in emerging economies such as China, Dishonest customers

3) Priority for State Owned Enterprises - high risk and low quality investments ▪ SMEs become cash strapped/neglected when want loans
▪ Long term collusion with commercial banks and govt
▪ Local govt’s misallocation of resources to SOEs

Chinese govt doesn’t restructure SOEs as they employ massive amt of labor. The cost of restructuring would be too high to make it worth the effort

4) Soft budget constraints
▪ Banks expect govt to bail them out if need be. Less concerned about losses ▪ Thus, China’s strong credit culture exacerbate the Non-Performing Loan problem\

5) Failure of market discipline

For there to be market discipline:
a) Banks must not expect bailout,
b) Borrower must be able to respond to market signal
c) Competitiveness of capital markets
d) Availability of information on borrower’s outstanding liabilities

▪ Soft budget constraints and readily available public money = failure of market discipline ▪ Exchange and capital markets not sophisticated enough to...
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